CL-Case-1 Round-Bankers of the World (ENG)

8/6/2019 CL-Case-1 Round-Bankers of the World (ENG)

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1st round Case Changellenge >> Cup Russia 2011:Bankers of the World: The role of the Bank of

Moscow in International Financial Centrecreation

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IntroductionColleagues, we met last December, but some time has passed

since then, and I would like to hear now about what has been done overthis period, and what concrete steps have been taken in developing the

Moscow financial centre.Dmitri Russian President (March, 4, 2011)1

It has been approximately two years since the President and the Prime Minister of the RussianFederation raised the question concerning the development of Moscow as an international financialcentre (IFC). A suitability of attracting members of financial society, self-regulating organizations, financialmarket professionals and specialists from leading IFCs to develop and implement this task wasrecognized.

In August of 2008 the Moscow Government released an order concerning immediate arrangementsof developing Moscow as an IFC. In July of 2009 the Russian Federation Government approved ofactivities to create an international financial centre in the Russian Federation.

In June of 2010 in order to start an implementation of the given task the Working Group under thePresidential Council for the Financial Market Development was formed to create an international financialcentre in Russia. First Deputy Prime Minister of the Russian Federation I.Shuvalov was charged with the

project, A.Voloshin was appointed a head of the Working Group.In August of 2010 the Bank of Moscow was also invited to become a member of the Working

Group. Nevertheless, despite the fact that the Bank was working on certain issues of the IFC forming(within the Group as well as independently), the preparation of a complex IFC forming Strategy becomesnecessary only at the moment.

In 2010, a long-awaited law against the improper use of insider information and marketmanipulation was passed. At the very end of the year an international advisory council to establish anddevelop a Global Financial Centre was established. Respected foreign and Russian financiers havebecome its members.

Finally at the beginning of this year the decision to merge the two Moscow stock exchanges - theMICEX and RTS - was made, which should make the work of the Russian stock market moreunderstandable and user-friendly for investors.

And on March 3, 2011 the Russian President signed a decree "Of measures to improve the

government regulation of financial markets2". The decree provides for the accession of the Federal

1 www.kremlin.ru
mailto:[email protected]:[email protected]:[email protected]


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Service for Insurance Supervision (FSIS) to the Federal Financial Markets Service (FFMS) with thetransfer of Federal Financial Markets Services Control and Supervision of insurance activities functionsand the establishment of specific opportunities for the joint service which includes the legal regulationfunctions, control and supervision over the financial market, subject to banking and auditing. Thus amega-regulator is finally created in the Russian financial market. The idea is not new and is quite logical.It is not only investment companies, but also insurance companies and pension funds which areinstitutional investors. Moreover, it is not uncommon that they are combined within one financial holding.

On March 4, the President of Russia Dmitry Medvedev held a regular meeting regarding the issueof the formation of the Global Financial Centre (GFC) in Moscow. According to Medvedev, the countriesof G20 are now trying to exert the global financial system to the maximum in order to ensure their ownfinancial security and economic stability. Therefore, operating financial centres, both international andregional, will remain the most effective instrument of the international influence and the solution to thenational problems which are posed as targets by separate states.

As RIA Novosti reports3, the President stressed that the creation of the GFC in Russia directlydepends on the solution of two problems. "The first challenge is the financial architecture of the GlobalFinancial Centre. The centre should be established in Russia, where all the main types of financialinstruments would be presented, "- Medvedev said. In this regard, international accounting standards forissuers and for regulatory and tax authorities should be introduced as soon as possible.

The second issue to which Dmitry Medvedev drew attention is the urban infrastructure of the GFC."Our task - he stressed - is to bring Moscow to the level of the leading financial capitals". Naturally,

criteria and standards that are accepted in the world will be used.The second major practical issue that was discussed at the meeting on March 4 is the prospectsof implementation of the international financial reporting standards (IFRS) in Russia. This topic is aurallypresented for more than a decade in Russia and a number of regulations were adopted in this regard.The largest Russian companies working closely with foreign investors have been providing financialstatements according to the IFRS for the past several years. For example 61 companies from the tophundred in Russia do so and also 45 companies from the second hundred. Nevertheless, the DeputyPrime Minister and the Finance Minister of Russia Alexei Kudrin acknowledged that the application of anumber of IFRS will be difficult as some of them do not have any countertypes and some are too much inconflict with the existing ones in Russia. The Minister of Finance considers that six international standards(out of 38) can be fully applied in the nearest future in Russia.

At the same meeting, the Mayor of Moscow, Sergei Sobyanin told about six important aspects ofthe development of Moscow as the Global Financial Centre. The first one is the development of the city

transport system. The second is the development of health services of the capital. The third is education,both at school and at a higher level. The fourth is the environment protection. The fifth is the developmentof information technologies in the city. The sixth one is the security issues in the city.

On March 8, 2011 "Interfax", referring to The Financial Times and The Wall Street Journal,reported that the advisory board will be formed of the heads of some of the world's largest investmentbanks in Russia that will work with the establishment group of the Global Financial Centre. Theinternational advisory board, according to the newspaper, will include senior officials of the Bank ofAmerica, Blackstone, BNP Paribas, Goldman Sachs, JP Morgan and Unicredit Bank. At the same time, itwas reported that the Russian government establishes a fund of $ 10 billion for a joint investment with theworld's leading companies. According to Bloomberg such funds as Apollo Management, Blackstone andCarlyle, as well as the biggest sovereign investment funds like Singaporean Temasek Holdings andChinese China Investment Corp. have already received the offer to participate in the project. Though,according to the unofficial statements4, the Carlyles representatives have already refused the Russian

authorities. The Fund had a negative experience on the Russian market in 2005 Carlyle closed itsMoscow office for the reason of extra risks for investments. Since then, it appears, the companysmanagement has not changed its mind. Russia did not prove its the place where Western Funds ofdirect investments can make profits despite the occurring risks, said one of the Carlyles directors DavidRubenstein last week.

All these pieces of information have again raised the question of creation of the the InternationalFinancial Centre in the city of Moscow as a priority task. Strange as it can be, among all the questions,touched upon at the latest meetings, were examined almost all the aspects of the development of theMoscow Financial Centre except one. Today, the Centre of Strategic Development of the Bank ofMoscow has to develop and present by the next meeting with Igor Shuvalov the whole complex ofmeasures to assist the creation of the Moscow Financial Centre in Moscow. These measures shouldrepresent, first of all, the development of the human capital of Moscow instead of global reorganization ofthe financial structure or modernization of legislation (these are the governments tasks).

2 http://www.fcsm.ru/ru/press/interviews/index.php?id_3=7079&year_26=2011&month_26=33 The newspaper "Voice of Russia, March 6, 2011, Aleksandrov Ivakhnik4RBC Daily:http://www.rbcdaily.ru/2011/03/09/world/562949979822984
http://www.rbcdaily.ru/2011/03/09/world/562949979822984http://www.rbcdaily.ru/2011/03/09/world/562949979822984http://www.rbcdaily.ru/2011/03/09/world/562949979822984http://www.rbcdaily.ru/2011/03/09/world/562949979822984


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Increasing the citizen financial activity and competence, development of respective servicesoriented on the population involvement in the economic turnover, forming an institute of financialconsultants and intermediaries etc. must be the top-priority subject of the Strategy. Your immediate chiefYakov Borisovitch Perelman has formed the following additional requirements to the strategy according tohis own examination of the problem:

Take notice that your developed arrangements should not only solve socials problems but alsosatisfy the Bank interests, increase banking product sales, expand its client base. The Bank of Moscow isprimarily interested in practical recommendations, realization of which is possible within 5 years. Ideas offinancial instrument usage activation, innovation channels of financial service promotion, cross-selldevelopment mechanism, forming the client management these and other topics can be the subject ofyour team's research. Do not abandon the analysis of the leading IFCs and the best European bankswork. What is widespread in Europe nowadays may only be fashion trends and not actually practiced inRussia.

We also recommend taking a closer look on the Russian Federation (particularly Moscow)competitive advantages which can be used in the creation of the IFC an opportune time zone, a systemof values similar to the western one, a broad internal market. This is the basis on which your casesolution logic can be built.

It shouldn't be forgotten that the IFC forming is not only an ambitious and fine-looking task but isalso a real project which should be carefully thought and proposed practically feasible initiatives. Forminga regional financial centre should become the top-priority goal as it is important to be competitive in

comparison with our nearest neighbors: Poland, Ukraine, the Baltic States.The Bank of Moscow is expecting calculations from you to corroborate your suggestions (this is aminimal requirement). In case you build a complex financial model such an approach will be welcomedand marked respectively by the jury.


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ContentIntroduction ....................................................................................................................................... 1

Financial Centre ................................................................................................................................ 5

The main participants of the Russian capital market ....................................................................... 10

Review of Capital Market ................................................................................................................ 12

Plans for capital raising. Investors. .................................................................................................. 13The main categories of the public and the extent to which they participate in the use of financialproducts .......................................................................................................................................... 16

Financial products and their penetration on the Russian market of physical persons ..................... 19

The bank of Moscow ....................................................................................................................... 21

Appendixes ..................................................................................................................................... 26

Appendix 1. Rating of the world's financial centers GFCI 2007-2008 .......................................... 26

Appendix 1 (Continuation). Rating of the world's financial centers GFCI 2007-2008................... 27

Appendix 2. The GFCI World ....................................................................................................... 28

Appendix 3. The dynamics of the international financial centers ................................................. 28

Appendix 4. The structure of assets and liabilities of the key player ............................................ 30

Appendix 5. Data on the stock market ......................................................................................... 35

Appendix 6. Data on the bond market ......................................................................................... 37

Appendix 7. Russian pension system .......................................................................................... 38

Appendix 8. Investment potential of individuals ........................................................................... 39

Appendix 9. Method of calculating of the components of the index of confidence to financialinstitutions.................................................................................................................................... 40

Appendix 10. Research ............................................................................................................... 41

Appendix 11. Using of banking products ..................................................................................... 44

Appendix 12. Digital office of the Bank of Moscow ...................................................................... 45


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Financial Centre

Main information about financial centresBank robber Willie Sutton reputedly (he denied this later) replied to a reporters inquiry on why he

robbed banks by saying because thats where the money is. In a circular fashion, why do we havefinancial centres? Probably the most important reason is because thats where the clients are. Globalfinancial centres are places with intense concentrations of financial professionals and their firmstransacting international business.

Financial centres funnel investment toward innovation and growth. Vibrant, competitive financialcentres give cities economic advantages in information, knowledge and access to capital. A strongfinancial centre, whether domestic, niche, regional, international or global, connects the wider economy tothe global financial community. Cities that are part of the global financial network gain from global tradeand growth. Inward and outward investment opportunities increase the wealth of cities that have financialcentres and the wealth of their citizens.

Successful financial centres can and do fulfill more than one role:

Global financial centres that are truly global foci, where only a few can claim that role(London, New York, Hong Kong and Singapore);

International financial centres such as Seoul or Shanghai or Frankfurt that conduct asignificant volume of cross-border transactions;

Niche financial centres that are worldwide leaders in one sector, such as Hamilton inreinsurance or Zurich and Edinburgh in fund management;

National financial centres, often within federal countries, that act as the main financialcentre for financial services within one country, such as Toronto or Frankfurt;

Regional financial centres that conduct a large proportion of regional business within onecountry, e.g. Boston or Vancouver.

Global financial centres are not hub-and-spoke arrangements. A Sydney mortgage bank may wellbe working on regional financial deals but the bank s international dealings could be direct with counter-parties in London or New York City. You cannot compartmentalize financial services distribution neatlyinto a typical retail model a central warehouse, then a regional distribution centre and finally a localstore.

In addition to this, at present time the World Financial Centre in the country becomes a necessarycondition of a strong economy. The countries with the World Financial Centres possess a series of

advantages: a multilayer and stable financial market, sovereign economy, maximally open markets thatjoin the global division of labor from the position of strength and freely convertible national currency. Theabsence of developed internal markets leads to the dependence from foreign capital, the necessity to getisolated from the global economy, flight of capital on foreign markets and weak currency.

Thus, its difficult to underestimate the role of the Moscow Financial Centre in the modern world.The national financial system that exists in the form of the world finance centre is now the most importantfactor of the global rivalry between countries. In the next 20-30 years the trend will not but strengthens.The survey made in November 2009 January 2010 by the Institute of Postcrisis World among 247experts of 54 countries showed that in the next 10 years the main factors determined the competitiveadvantages of countries will be human capital (45%), natural resources (36,1%), new high technologies(32,9%), efficient financial sector (19,4%), innovations in administration of the government (17,1%).Moreover, the human capital and the innovations in administration of the government are two obligatoryconditions in forming an efficient financial sector.

The final aim of the development of the financial centre in Moscow is to provide it with the financialconditions for a stable and quality economic growth by attracting wide categories of foreign investors to:increase the volume of capital investments into the real sector, increase the capitalization of the financialsector, reduce the expenses of financing and world diversification of risks.

Nowadays the rates of the world and regional financial centres are being gradually formed. Theserates help compare the advantages of certain financial centres. In the future they can become criteria forthe efficiency of programs of the financial institutions creation.

The most accurate rate of this kind is GFCI - Global Financial Centres Index- in Londons Citypublished by the research company Z/Yen Group Limited. It was published for the first time in March2007. This index is counted on the so called factors estimation model which includes rates of countries oncertain formal indices with the evaluation of financial experts.

Different aspects of competitiveness are being analyzed like people (qualified staff, flexibility of thelabor market, business-education), business-environment (the regulation of business, taxation, corruption

level, easily realized business projects), availability of the market (the securitization level, multilayerfinancial markets), infrastructure (the cost and availability of real estate objects), general competitiveness


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(the difference between cumulative competitiveness and the sum of the above mentioned factors ofcompetitiveness).

According to the latest GFCI rate for 2010, currently the rate of attractive world financial centres isthe following: 1) London, 2) New-York, 3) Hong Kong, 4) Singapore, 5) Tokyo, 6) Shanghai, 7) Chicago,8) Zurich, 9) Geneva, 10) Sydney. Moscow occupies the 68th place, Saint-Petersburg the 71st.

However, its important to point out that this rate of financial centres cannot remain changeless, aswell as investors interests. You can find different GFCI rates in the Appendix (Appendix The Dynamicsof the Positions of the World Financial Centres)

5.

International Financial CentresThe most important feature of modern financial world is high competition. According to the latest

GFCI rating, although London, New York and Hong Kong are ranked first, second and third respectively,there is no essential difference between them. Besides, Singapore is very close to the first triple.

Whilst many industry professionals still see a great deal of competition, policymakers appear torecognize that working together on certain elements of regulatory reform is likely to enhance thecompetitiveness of both centres.

The main question of the global financial society nowadays is who will play the main roles in thenearest and further future? Is the situation going to be the same? Or will the financial activity centre movefrom the West to the East following the main industrial one?

The frightening tendency of Asian expansion becomes more real for the Western traditional

financial centres. In the latest rating 4 out of 10 most important financial centres are situated in Asia Hong Kong, Singapore, Tokyo and Shenzhen. Some experts predict they will play the leading role in theworld financial system in the following years.

However, the majority of experts suggests that in the following 10 years London and New York willkeep their leading positions in the world financial system as they have maximum current indexes of themost significant factors, such as the presence of qualified specialists and favorable and predictablebusiness conduct environment. 17 out of 500 world's biggest universities are situated in London, 19 inNew York. 11 out of 100 tip universities granting MBA degree are in London, 9 in New York.

The another key factor which contains complex state support of the financial sector evaluation,economic liberties, transparency, financial sector regulation predictability and tax treatment, shows thatSingapore is the 1st, Hong Kong the 2nd, London the 3rd. In infrastructure development indicatorTokyo is the leader, Chicago is on the second place, London is on the third.

Traditional financial centres such as London and New York lose to younger financial centres suchas Singapore, Hong Kong and Tokyo in many aspects but nevertheless remain the leaders. Why is that?The financial centre reputation is the answer: the older and more reliable financial centre is, the moreattractive it is to investors. Geneva, whilst being well-connected, is seen as a high quality specialist in thefield of Asset Management, rather than offering a fully diversified service, and is hence assigned a profileof Global Specialist.

Amsterdam, Dublin and Paris are Global centres with strong international connections. They do nothowever exhibit sufficient depth in financial services to be considered as Global Leaders, but as GlobalDiversified Centres6.

In the previous years Asian financial centres have shown remarkable growth, with Hong Kong andSingapore as the leaders. They are well known globally, and have a rich environment of different types offinancial services institutions. Beijing and Shanghai are well connected and are assigned the profile ofGlobal Specialists they do not yet offer a sufficiently developed and diversified service to be GlobalLeaders. Seoul and Tokyo are assigned the profile of Transnational Leaders although Tokyo is very closeto becoming a Global Leader and we would expect them to attain that status soon.

There are 4 Middle East financial centres in the GFCI 2010 rating the leader of which is Dubai. Inthe previous years many experts predicted that Dubai would have leading positions in the world financialsystems but the situation has radically changed during the last year: financial crisis revealed considerableproblems in the development of Dubai as a global financial centre. However, despite all the problems,Dubai remains the strongest Middle East regional centre.

The role of North American counties in global financial system development is difficult tounderestimate. American dollar has been a world main calculation currency. Despite the financial crisis of2008 and all the pessimistic predictions, dollar and American financial system stability remain almostabsolutely constant relative to the exponentially growing USA national debt. High position of Americanfinancial centres in the rating is mainly explained by a strong internal market. Moreover, North Americancities benefit from great legal and political frameworks and economic stability, while also being great inknowledge creation and information flow, though scoring less in comparison to the top European and

5 Attachments "The Dynamics of the Positions of the World Financial Centres"6 GFCI 2010


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Asian cities in several dimensions such as ease of doing business, financial flow and business centres7.Size of the internal market has great significance to the USA. Lots of specialists think that the size ofNorth American internal market and high domestic demand have played a very important role in thedevelopment of New York as a global financial centre. Chicago has importance as well as New York.

Chicago is not just strong in derivatives trading, for which it is probably best known, but is a realall-rounder featuring in the top ten in the Asset Management, Banking, Insurance, Professional Servicesand Government & Regulatory sub indices as the latest Z/Yen research shows.

World experience shows that the IFC forming effects the economy beneficially. For instance,Dublin IFC encouraged creation and development of modern financial infrastructure, provided investmentinflow in telecommunication infrastructure and created high-paying jobs. Its main advantage is acombination of well-educated English-speaking population and relatively low cost base, due to what thiscountry has the lowest unemployment rate in the Euro zone. In 2007 there appeared a tendency of higheradded value services which created higher-paying jobs.

Hong Kong IFC attracted more than 3845 foreign companies. Almost a third of them opened theirregional centres on the territory which favored quick economic growth. Apart from that, IFC forming led tocreation of the world's largest freight service airport, second largest container port and one of the leadingtelecommunication centre in Asia-Pacific region.

IFC creation in Dubai assisted in positioning this centre as a potential Middle East regional financialjunction due to gained experience and build confidence in the financial market.

Singapore IFC stimulated the national sector of the financial service development, and nowadays

Singapore banks are considered as ones of the most developed in the region.World experience in the forming of and international financial centre without a doubt will be usefulin the Moscow and an IFC development strategy

London

Gross domestic product (2005): $452 billion8GDP (2020): $708 billionGrowth rate: 3%GFCI Ranking: 1MasterCard Ranking: 1Population (2010): 8,556,900Purchasing power (NYC=100): 92%

By 2020, London is expected to leapfrog Paris

and become the Europe's richest city as measured byGDP. London's 3% growth rate is high for a major cityin the developed world. London is ranked as the No. 1city on MasterCard's Centres of Commerce index,owing to the vast volume of its financial markets. It'scomparable to New York in equities and commodities

trading but is larger in bond and derivatives trading. The downside? It's expensive. The purchasingpower of the average Londoner is less than their New York peers.

Currently London is the world's largest financial centre according to the GFCI 2010 rating.London's dominating position in global financial market is caused by many reasons. Its historical

development is probably the most significant one. London is the oldest financial centre not only in Europebut in the world. It's been London that has been playing the main part in both global money market andcapital one due to strong economy and the pound sterling position as a world gold standard for a long

time.For many years London was a financial capital not only of the UK but of all the British Empire

countries (Canada, India, Australia etc.) which resulted in strong economic and financial connectionsbetween the countries. Connections with the USA in all areas of economy are traditionally strong as well.English being the native language and the dominant international language of business is also playing itspart.

London as a financial centre uses its geographic advantages well. Its location in a central timezone allows it to act as a bridge between US and Asian markets.

Creating an enabling environment of business conduct and investor protection is a key to capitalrising. There is a preferential tax treatment for the foreign investors in the UK as the income tax rates arerelatively low and foreign exchange reserves for nonresident aren't taxed at all.

7According to Mastercard The Worldwide Centres of Commerce Index8 Here and later data is published according to Worlds Most Economically Powerful Cities by

Forbes, 2008


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One of the advantages of London as an international financial centre is a business friendlyenvironment (e.g. in the City of London the local government is not elected by the resident population butinstead by business - the City of London is a business democracy).

Well-developed infrastructure is another factor of a financial centre efficient functioning. There is nofinancial centre without infrastructure. According to the PwC Cities of opportunities

9 report ininfrastructure level of development London is on the 3rd place losing only to Tokyo and Chicago.

One the most famous elements of London infrastructure is The London Stock Exchange which isone of the European largest and oldest exchanges and one of the most famous world stock markets.From conducting its business in the coffee houses of 17th century London, the Exchange is one of theworlds oldest stock exchanges and can trace its history back more than 300 years. The Exchange is themost international of all the worlds stock exchanges, with around 3,000 companies from over 70countries admitted to trading on its markets. And over 400 firms, mainly investment banks andstockbrokers, are members of the London Stock Exchange.

The London Stock Exchange has these core areas: the Main Market that includes the companieswhich meet the Financial Services Authority requirements and Alternative Investment Market (AIM)

10that

allows smaller companies to float shares with a more flexible regulatory system than is applicable to themain market.

The City is home to banks, brokers, insurers and legal and accounting firms. More than half of theUK's top 100 listed companies (the FTSE 10011) and over 100 of Europe's 500 largest companies areheadquartered in central London. Over 70% of the FTSE 100 are located within London's metropolitan

area, and 75% of Fortune 500

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companies have offices in London.Currently London produces nearly 20% of the UK GDP 13 while gross regional product of themetropolitan area reaches almost 30%. London's largest industry remains finance which includes bankingservice, insurance, asset management and employs almost 300000 people. London financial exportsmake it a large contributor to the UK's balance of payments.

New York

GDP (2005): $1.13 trillionGDP (2020): $1.56 trillionGrowth rate: 2.2%GFCI Ranking: 2MasterCard ranking: 2Population (2010): 19,006,000Purchasing power: 100%

In absolute terms, the economy of New York City is second only toTokyo. In fact, there are only 14 countries in the world with bigger economiesthan New York. And though the city has a reputation for a high cost of living,the average New Yorker can buy more than counterparts in London, Paris,Tokyo and Hong Kong.

Hong Kong

GDP (2005): $244 billionGDP (2020): $407 billion

Growth rate: 3.5%GFCI Ranking: 3MasterCard ranking: 6Population (2010): 7,055,000Purchasing power (NYC=100): 49%

Hong Kong benefits from its physical proximity to the Chinese mainland and its historicalconnection to Western markets. MasterCard ranks Hong Kong the best business centre in the world,based on a composite of its ports, airports, hotels and commercial real estate development.

9http://www.pwc.com/cities10 It is in this market is mainly hosted by Russian companies.11 FTSE 100 Index (Financial Times Stock Exchange Index) - Stock index, calculated Agency

Financial Times12 Fortune 500 - the list of the largest companies in the US on the American version of themagazine Fortune

13 Already mentioned study of Forbes
http://www.pwc.com/citieshttp://www.pwc.com/citieshttp://www.pwc.com/citieshttp://www.pwc.com/cities


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SingaporeGDP (2010): $255 billionGDP (2020): $402 billionGrowth rate: 3,3%GFCI Ranking: 4.MasterCard ranking: 4Population (2010): 5,076,700

Singapore is unique city: in fact it is a one city country.Singapore's external trade is of higher value than its GDP,

making trade one of the most vital components of the economy. Thus it has always been very importantfor the city to develop itself as a business destination. At the city made it as both GFCI and MasterCardrankings have shown. Moreover nowadays Singapore is the world's fourth largest foreign-exchangetrading centre after London, New York and Tokyo14. And finally The World Bank ranks Singapore as theworld's top logistics hub.

TokyoGDP (2005): $1.19 trillionGDP (2020): $1.6 trillionGrowth rate: 2%

GFCI Ranking: 5.MasterCard ranking: 3Population (2010): 35,676,000Purchasing power (NYC=100): 96%

Tokyo is the world's most populous city by the U.N.'s reckoning, and ithas the largest economy. By PricewaterhouseCoopers' projections,

Tokyo will still have the largest economy in 2020, though New York will be getting closer. Tokyo's hugesize comes at a price: Of the 151 largest economies, its growth is expected to rank at No. 140.

The creation of Moscow Financial CentreObviously, financial centres do not only have authority in the world economy but can as well

influence politics. A strong financial market is becoming an obligatory condition for the countries claiming

to be the world leaders. If Russia doesnt want to be isolated from the world economy and lose anyinfluence on the world political arena, it should seriously think over the possibilities of strengthening itspositions in the world financial system.

Currently Russia has a more or less developed bank loan system, but the stock market can hardlycompete with the global ones.

The stock market in Russia is a typically huge developing market. Its characterized, on the oneside, by high pace of positive quantity and quality changes, and on the other side by a number ofcomplex problems that impede a more efficient development of the market. Most of the indices of themarkets capacity place Russian stock market among the first five countries in the rate of developingmarkets. The number of quality indices moved Russia to the leaders among the developing markets.However, other quality indices (like the markets liquidity, dividend yield, the number of traded companiesetc.) show Russia is left behind the leading developing markets, not to say the developed ones.

On the one hand, the Russian stock market has already begun fulfilling the macroeconomics

function of transformation of savings into investments. More and more enterprises of the real sector beginconsidering it as the main source of attracted resources for financing investments in basic capital andrivals takeovers.

On the other hand, the Russian stock market is not yet a significant instrument for the population toearn money as well as the source of investment resources for most of companies. Thus, it cant fulfill thewhole spectrum of its functions.

The unbiased globalization processes in the world capital market raise a question of the survival ofthe national financial market in Russia. There remains a problem of building an efficient marketinfrastructure that can satisfy the needs of local and foreign investors.

Finally, a serious constraining factor in the stock markets development in Russia is a poorinvestment climate. This fact impedes foreign long-term investors from coming to Russia where still anurgent problem of lack of foreign investors exists15.

As a result, in the next 10 years the Russian stock market has two absolutely different alternatives:

to stop its existence becoming a part of the world financial market or turn into a developed market.

14 "Annual Report 2008/2009". Monetary Authority of Singapore.15 Report "The Russian stock market and the creation of an international financial centre"


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The consequences of the first alternative seem to be terrible: the Russian enterprises may see theexpenses of capital raising highly increased, and the possibility of efficient allocation of the capital goneaway. The lack of investment opportunities can even lead to a slowdown of the middle class formationand the outflow of the most skilled workers abroad

The financial market disappearance will deteriorate the financial condition of the state. Thereduction of opportunities for capital raising by the national companies will lead to a slowdown of thedynamics the economy and tax revenue reductions. The transfer of domestic enterprises into otherjurisdictions may lead to a drastic cut down of tax payments made by them within their current jurisdiction.An increased vulnerability of the national currency will reduce the investment prospects of all instrumentsdenominated in this currency, including government securities, which will significantly decrease thestates debt financing ability concerning the emerging deficits. The outflow of skilled labor also results inthe tax payments budget reduction.

In this regard the concern of the Government seems to be quite understandable. If the decisiveactions are not made now, it might be too late to change anything. However, not all experts believe thatRussia will achieve the desired result or it can accomplish the task quickly.

For example, Lucio Vinhas de Souza, World Bank economist reports Moscow is unlikely tobecome an international financial centre and can only aspire to be a regional financial hub.

H is added by Dunkan Niderauer, the head of New York Exchange: "The vital things are: theeconomy that has great potential growth, stable currency, stable political system, a well-functioningcapital market, good, but not excessive, regulations, talented specialists".

Interesting information is provided by Robert Idelson from M2M bank: Moscow has alreadybecome a local financial centre but it is difficult to imagine that in terms of private banking it can competewith Europe or the USA. Even Russian elite prefer to keep the money in Europe, the USA or Asia directly or mediately. If we look at the Russian capital market, it is obvious that its overregulation impedesto obtain funds. Weve heard a lot about a big advantage Moscows time zone. In fact, this is not theadvantage: global players have offices in Hong Kong, New York and London. This axis is already formed.Moreover, financial markets need 100% predictabilitywe can not say so about Moscow.

Finally, according to the words of Ilya Ryabyi from MasterCard: The biggest problems are thoseconnected with business dealing. But they are very easy to overcome much easier than improving livingstandards. Business, including financial one, choose places where it is easier to exist. From the creationof financial center in Moscow first win tough Muscovites. And after all ordinary Muscovites.

However, opinions stay opinions and the real measures already need to be taken now. With theformation of the GFC a number of tasks with regard to the development of the financial market of Russia

were planned:Attraction of the foreign and domestic resources to the economy of Russia to finance themodernization, to form a brand new financial infrastructure, productive assets and technologies, to investin the human capital.

An increase in the investment efficiency through the use of market instruments and infrastructure,an investment instruments development and risk diversification, a transaction costs cutback.

Engagement of the new technologies (in the form of purchases, direct foreign investments,attraction through the capital shares), including the creation of innovative platforms.

An increase in the Russias competitive ability globally and its acquisition of the leadership in theCIS and Eastern Europe, a promotion of Russian products and financial services on the foreign markets.

Control over the prices for Russian assets and the ownership structure: the transfer of assetspricing (both of the raw materials and the shares of domestic enterprises) into the jurisdiction of theRussian Federation in the area of the Russian national currency.

Engagement of the new technologies (in the form of purchases, direct foreign investments,attraction through the capital shares), including the creation of innovative platforms.An increase in the Russias competitive ability globally and its acquisition of the leadership in the

CIS and Eastern Europe, a promotion of Russian products and financial services on the foreign markets.Control over the prices for Russian assets and the ownership structure: the transfer of assets

pricing (both of the raw materials and the shares of domestic enterprises) into the jurisdiction of theRussian Federation in the area of the Russian national currency.

The main participants of the Russian capital marketSince it is the stock market has to undergo significant changes, the most interesting topic of

research is its current status.Private investors, companies, the government, banks, tycoons, foreign investors, pension capital

fund, mutual funds and insurance companies are the main players on the Russian financial market.Banks have the largest share of assets (about 29%), the government ranks the second place for totalassets (22%), and foreign investors take the third place.


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Private investors. Gross financial assets of the Russian population amounts to 26% of GDP. Forcomparison, this indicator amounts to 279% of GDP in the USA. Bank deposits are the only type ofassets by which financial assets of private individuals are compared with the same indicator in the USA.The volume of other kinds of long-term investments of Russian population is very small.

Companies. Banking deposits of companies are $330 bln, or 21% of GDP, which is higher than inthe US, where corporate deposits are only 17% of GDP. The main reason for this is the lack of alternativeopportunities for companies to put their capital to work.

Russian companies are surprisingly highly indebted, with some $725 bln in debt. The majority ofthis is to Russian banks, with another large amount in syndicated debt to Western banks. In Russia thedomestic bond market for companies is tiny.

Government. The Russian government has assets of $500 bln, held mainly in foreign bonds, with avalue of around 33% of GDP. In addition, the government owns $298 bln in listed equity market assets,according to our calculations, or some 20% of GDP.

Liabilities are low at just 10% of GDP in Russia, versus well over 100% in the US.Banks. Russian banks have $1trillion in assets, or 70% of GDP. This is comparable with the US,

where commercial banks have assets equal to 100% of GDP. The reason why the two are comparable insize in spite of the smaller amount of assets in Russia is that in the US, there are many alternatives tobanks, but in Russia (as in many other emerging markets) the banking sector acts as the key financialintermediary to the economy. In Russia, there are far fewer consumer loans than in the US, and thecorporate sector is disproportionately important. Both banking systems are largely funded by deposits.

The Russian banks have a far smaller share of bonds outstanding, however, as well as a relatively largeamount of syndicated debt, which we estimate at $95 bln.Oligarchs. There is no detailed data on the assets and liabilities of the Russian oligarchs, however,

there are have some inferred numbers. Oligarchs and management teams own $299 bln in equity indeclared stakes in listed Russian companies, as well as around $73 bln in what we assume to be closelyheld stakes. This is a total of 25% of GDP, which is relatively large, being more than four times the size ofthe total institutional money. However, because of the lack of institutional money, these stakes are hard tomonetize, and we believe that this gives rise to an interesting conundrum: Russian oligarchs haveenormous paper wealth, but that wealth is dependent on relatively small free floats of shares largelyowned by foreigners. So, it should be in their interest to ensure that foreign minority investors are welltreated and that dividend streams are high. However, minority shareholders are for the most part notespecially well treated, and dividends are low. It is this dynamic that makes the Russian market so volatileand dependent on foreign perception, and that drove it to such low levels in the dark days of 2008.

Foreign capital. There is remarkably good data on the amount of foreign capital in the equitymarket. Foreigners own about 75% of total volume of shares. Besides, they own $20 bln of ruble debt,some 13% of the market, as well as $97 bln of hard currency debt, some 70% of the market, and almostall of the $291 bln in syndicated debt (to both companies and banks). There is a separate question, ofcourse, as to how much of this foreign money is in fact Russian investors recycling their money back intothe market, but this issue is remains an open question. Foreigners therefore own 39% of Russias totalGDP through syndicated debt, traded debt and equity. While this is lower than in the US, it is a muchlarger share of the total amount of capital available as a result of the lack of domestic capital.

Pension funds. The Russian pension system has a total of $48 bln in assets, half in thegovernment fund, VEB, $4 bln in managed government funds and $20 bln in private funds. This is a totalof just 3% of GDP. This is very small in the global context. The US pension system has 52% of GDP inprivate schemes and 28% in public schemes. Moreover, there are some markets like Chile, where assetsin the pension system are as high as 65% of GDP. It is nevertheless worth noting that there are other

markets like Germany or France which have yet to grasp the nettle of moving from a pay as you gosystem, and which also have very small amounts of long-term pension assets.Mutual funds. Data from investfunds.ru imply that the total size of the Russian mutual fund industry

is no more than $14 bln16, less than 1% of GDP. Of this, $3 bln is in open-ended PIF funds (the mainsource of pooled equity investment) and $7 bln is in property funds, which are often used as a vehicle forprivate property investment. In contrast, the US has mutual fund assets of 66% of GDP, in Poland it is 8%of GDP, and many other markets have mutual funds of well over 10% of GDP.

Insurance companies. According to the insurance regulator, the insurance sector runs $12 bln offunds, less than 1% of GDP. Of these, just $2 bln are in equities, In contrast, the US system has 34% ofGDP.

16http://investfunds.ru/
http://investfunds.ru/http://investfunds.ru/http://investfunds.ru/http://investfunds.ru/


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Review of Capital Market

Stock marketThe stock market of Russia is, above all, a developing market. The ratio of the total market capitalization

and GDP makes it big enough in the global context, but the necessary infrastructure is underdeveloped. Animmaturity of the necessary institutions, the lack of an adequate legislative protection of investors and,consequently, a high country risk does not make the market attractive enough for both foreign and localinvestors.

One of the most important features of the Russian market is high volatility. Furthermore, the positivenews is often perceived suspiciously, while negative information is able to bring down the entire market.

Secondly, the Russian stock market is characterized by high concentration, both in terms ofcapitalization and turnover. 20 largest issuers account for more than of the national market capitalization.This index is gradually decreasing, and this reduction is quite stable. However, it is still extremely highcompared to the majority of the foreign stock markets.

Thirdly, the stock market in Russia is characterized by low liquidity (this applies not only to the stockmarket but to the bond market as well). Liquid stocks are only those of the major companies. The share of the30 most liquid stocks is 98.9% of the total exchange-listed stock turnover.

At the same time the trading volume is large (more than $ 5 billion a day). This is due to too high afrequency of the transactions made by Russian market participants. In particular, all the shares in the publicownership of Sberbank make a full turnover in the market during the week.

Another specific feature of the Russian stock market is the concentration of the capitalization incertain industries. First of all it is fuel and energy complex. The share of oil and gas companies isparticularly high. According to the Stock Market Development Centre this industry accounts for almost ahalf of the total capitalization of Russian companies.

Significant roles in the overall capitalization structure also belong to the financial sector, theenergetic, ferrous and nonferrous metal industries and the communications. The machinery,transportation and chemical industries, the trade industry, the constructions, the service sector arepresented extremely weakly in the sectoral structure of the stock market. A dynamic and stable growth ofcapitalization is hardly possible without a substantial industrial diversification of the stock market.

An equally important feature of the Russian market is the use of insider information. There arerumors in the professional environment that the inside part of the cost structure of large investmentcompanies is up to 40%.

With regard to the ownership structure, the state's share is estimated to be 29%, oligarchs and

management companies - in 29% of foreign strategic investors and corporate clients - about 12%. Theproportion of shares in free float is 30%. Given the fact that some owners prefer not to disclose thepackage share and hide it nominee, the real proportion of shares in free float is likely to be lower.Perhaps it is closer to 20-25%, ie, the value of these shares is approximately $ 250 billion. Share of freefloat is relatively small compared with other markets and market share controlled by the state and theoligarchs - is great.

Notable is the fact that Russian and foreign investors prefer to invest in different asset classes.First ones, as a rule, are more inclined to bet on the assets, the prospects are connected with thereformation of the sector (IDC Holding, OGK-2, IDC Urals, RusHydro). Foreigners are also much moreattracted issuers with good growth prospects, such as Sberbank, MTS, Magnet17 and Novatek18.

Government bonds market

By "government bonds the current legislation means both federal securities and securities thatbelong to the constituent entities of the Russian Federation; along with these securities there are alsoexist regional bonds which are issued by municipal entities.

The most part of an external debt of Russia falls on the bonds, thus more than a half is Eurobonds.The point is that the securities of constituent entities of the Russian Federation and regional bonds havesmaller volume than federal securities and corporate bonds.

The Bank of Russias bonds are not the government bonds officially, even though they have thesame reliability level. They are short-term securities and are used for commercial banks' liquiditymanagement, and other investors can't buy them.

It is well-known that market volume of the government bonds of Russia is not large. The aggregatepublic debt is equal to 64 billion dollars in rubles obligations and 25 billion dollars in Eurobonds. It is a

17

Magnet - the largest (by number of stores in July 2010) Russian chain of grocery stores,discounters. Headquarters - in Krasnodar.

18 Novatek - Russian Gas Company, the second-largest producer of natural gas production inRussia.


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very small size in comparison with a huge public debt of the USA with its Treasury Obligations MoneyMarket accounting for $8,6 trillion, and the municipal bond market which is equal to $2,8 billion.

The biggest part of the ruble government bonds belongs to local investors. In addition, more than ahalf of these bonds belongs to credit organizations and about a quarter belongs to pension funds.Physical persons have a rather insignificant part. Almost all the debt syndication belongs to foreigninvestors; they own about 70 % of the countrys trading foreign debt obligations.

Corporate bonds marketDevelopment of the Russian corporate bond market is characterized by steady increase in quantity

of emitters, lengthening of terms of loan and volume increasing. Along with ruble bonds Russiancompanies actively involved means from foreign markets by making their own Eurobonds. Though thismarket, generally speaking, is not a part of the Russian stock market, but for the enterprises, the capitalconsumers, it makes real alternative to involvement in financing by means of making internal ruble bondsor by means of bank crediting.

Currently the total volume of trading inner debt obligations made by Russian corporate borrowers isequal to $58 billion and the trading foreign debt accounts for $60 billion. This is also a small amount incomparison with American corporate bond market which accounts for $4.3 trillion and its property marketdebts is comparable to the corporate bond market.

Experts believe that the most part of ruble corporate bonds as well as the most part of a ruble statedebt belongs to Russian investors (61 % belongs to banks), and the most part of Eurobonds belongs of

foreign investors.As for the near-term outlook of the Russian corporate bond market there is the information that the

Russian corporate borrowers will aspire to involve about $20 billion of a pure debt in rubles annually and$20 billion in foreign currency.

Plans for capital raising. Investors.Considering the investors in the stock market traditionally the following groups can be stated: the

government, the corporate sector, private investors, non-residents, collective investment institutions andpension funds. From the viewpoint of formation of the financial centre collective investment institutions,pension funds, insurance companies and private investors are the most interesting the ones areconsidered institutional investors in the developed financial markets and deliver a significant portion offunds to their economies. And in many respects it is their pace of development that determines the

development of a stock market as a part of a financial centre.

Investment fundsThe growth of capitalization and liquidity of the stock market should be based on the internal

investment resources and the rapid growth of collective investments among them.The relative level of development of mutual funds industry in Russia currently is significantly behind

the vast majority of stock markets, except for Romania and China where the open-end investment fundslegislation became operational much later than in Russia. Despite the rapid growth of the economy andthe stock market in Russia in 2000-2009 the relative performance of mutual funds figures in Russia areclose to zero.

The growth of the Russian stock market over the next 10-15 years and its transformation into oneof the largest global capital markets sets an ambitious target of a quality change of the collective

investments industry in Russia.The following factors determining the dynamics of the assets of collective investment institutionsshould be indicated:

Factors that determine the amount of assets (the number of funds, the average size of thefund's assets, the number of management companies (MC), the average asset size andnumber of funds managed by one MC).

Determinants of the growth of assets (the number of personal accounts of shareholders,the average account size, the factors determining shareholders inflows).

Among these factors the number of personal accounts of shareholders and the average size of thefund's assets are manageable. The dynamics of the number of owners of personal accounts shows asteady growth currently.

The lag in terms of the average fund size is much greater than the one in the number of fundsbetween Russia and the developed countries. The analysis shows that this factor carries much greater

potential for the further growth of the total assets of the collective investment industry in Russia.Investment markets of countries can be divided into three groups according to the level of

development.


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Offshore international centres. Include three countries - Luxembourg, Ireland and Hong Kongplaying the roles of international offshore companies for global investment funds. In 2009, the shares ofassets of open-end investment funds registered in Luxembourg, Ireland and Hong Kong were,respectively, 5296.9, 349.3 and 333.0% of GDP of these countries. These countries are characterized byhigh levels of stock market development. The uniqueness of these countries for stockholders (fundinvestors) of international funds is a preferential tax treatment, a simplified registration form for funds andstability of business conditions and opportunities of the data analysis of resources. Interestingly, asLuxembourg has a long history as a centre of attraction for international investment funds, Ireland andHong Kong have become such centres only in the last 10-15 years.

Countries with high levels of investment funds development. There are 18 countries, includingthe United States, France, Canada, Australia and Great Britain where the contribution of net asset valueof investment funds to GDP ranges from 10% to 100%. The average level of share of NAV of investmenttrusts in GDP is 26,5% for these countries over the past 15 years.

There are active stock markets playing important roles in national economies and investments inmost of these countries. With that, the assets of investment funds are very sensitive to the profitability ofdomestic stock markets.

Countries with a moderate level of development of investment funds. Joins a group of 14countries including Japan, Germany, Finland and Norway whose shares of investment funds in GDPrange from 1% to 10%.

In many countries a significant role in savings driving and investments belongs either to the

national (Germany, Japan, Turkey, Finland, Norway) or foreign (Slovakia. Poland, Czech Republic,Argentina) banking capital or to the retirement savings plan system (e.g. Chile). These countries usuallyshow notably lower rates of capitalization and liquidity of the stock market than countries in the first andsecond groups.

Russia, China and Romania present a separate category of markets in terms of the level ofdevelopment of open-end funds. The relative index of the level of development of investment funds inthese countries is close to zero. It reflects the still insufficient participation of people's savings in thecountry's investment and the capitalization of companies.

The most realistic benchmark for the growth of investment funds in Russia is a model thedevelopment of Japanese and German stock markets which assumes the achievement of the share ofinvestment funds in GDP at a 10-15% level. In this case, if the ratio is achieved, mutual funds will becomeeffective minority investors in the domestic stock market.

Pension fundsThere are three main parts to the Russian pension system. The main part is a pay-as-you-go

system, and this has been supplemented in recent years by some state and private asset accumulation,although these are still relatively small. The total pension assets under management are $48 bln, or 3% ofGDP. The main foundation of the Russian pension system is a pay-as-you-go system. Each year employersmake mandatory payments of 20% of salary (up to a $14,000 salary cap) into a government fund. In 2010, thiswill raise $59 bln. The government then adds $93 bln to this, and pays out $152 bln directly to pensioners.Clearly, then, in this system there is no saving or room for the accumulation of long-term money. The increasein pension payouts has been enormous, rising from 6% of GDP in 2007 to 10% today. Only recently has thestate needed to fund it to such a degree.

For those who were born after 1967, 6% of the payroll goes to individual accumulation accounts, wherethe plan is that they will be used after 2020. An individual may choose where to put this money, with the choiceto select either one of the 164 non-government pension funds or the state asset management company

controlled by VEB19

. If a person makes no choice, the money is left with VEB. As with most systems like this,most people choose the default option, and VEB ends up with most of the money.

The VEB funds have accumulated $24 bln, while the non-government pension funds have $4 bln. Theflow to these funds is $13 bln a year at present, a little under 1% of GDP. At present, the government hasproposed that this accumulation system be shut down and resources are diverted into the payment of currentexpenditures. However, a final decision on this has yet to be made

Employers now deduct about $ 2 billion a year, and employees - almost nothing. As a result, largeRussian funds, replenished by employers, have a total of $ 20 billion in cash. Funds, which means deduct theemployees themselves are still very small

Thus, by the level of development of Non-State Pension Funds, Russia is the world's outsider, trailingnot only from countries with developed stock markets, but the majority of emerging markets. As a result, therole of Non-State Pension Funds in the stock market remains virtually unnoticed.

19

Bank for Development and Foreign Economic Affairs (Vnesheconombank, VEB) - Russian state-owned corporation. It has not banking license and is an agent of the state foreign debt servicing,collection of accounts receivable of the former USSR, the management of the assets of the Pension Fundof Russia, as well as loans and guarantees to Russian exporters.


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Many experts believe that an important condition for the rapid growth of pension funds is the availabilityof a dynamic investment fund industry.

As targets of a level of development of private pension funds in Russia may be indicators of the countrywith the average parameters of the coefficients "Pension reserves to GDP" and "Pension Reserve /Capitalization". The country should have a high level of stock market development and have a strong bankingsystem. As such a landmark can be identified Japan, the stock market which presents a balanced pensionreserves. The share of investment and pension funds in Japan's GDP is respectively 13.3 and 4.4% incapitalization - 12,2 and 4,2%.

IndividualsIndividuals are the most important part of investors structure on the developed share market. In

countries with a high level of welfare system population guides the progress of the national share market.Its population that the most conservative global investors with a long -sighted investment first take intoaccount. The individuals involvement into investment business is the most important factor in thestructure of a multilayer national share market within which the biggest part of investment business isconcentrated.

The investment activity on the stock market depends on three groups of factors which are theindividuals income and welfare (the value of accumulated investment assets), the degree of thedevelopment of the private pension system (i.e. the individuals are responsible for the investment in themarket of its own pension capital), the households commitment to invest in securities instead of oth er

alternative investment objects.According to the table attached below, in Russia, only those groups of individuals those gain more

than 50 thousand dollars per year to spend on the household are able to invest. Based upon the averagerate of the individuals capital invested in securities (what makes about 1 % of the income per year) withthe income of 50 thousand dollars, the household can save about 1 thousand dollars per year. Thus,about 6 million households out of 53 million household have a real investment potential in Russia.

By 2012 the number of households with an investment potential will probably have increased to 12million, and to 20-22 million by the year of 2020. Theoretically, the level of the populations revenue canbe described as the most important factor that determines the individuals activity in the investmentbusiness on the financial market. But the problem is that the Russian index of the individuals revenue isinferior not only to the countries with a high income per capital, but also to many countries with asignificantly lower income. So, for example, in India the incomes level per capital (as to the purchasing-power-parity) 3,1 times lower than in Russia, but the number of people investing in shares is higher. The

Chinese level of income per head is 1,8 times lower than in Russia, but the number of the Chinese whoinvest in shares is 10 times higher than in this country.

If the ratio between the level of income and the number of people investing in shares in Russiacorresponded to the worldwide figures, the number of Russians who invest in shares would increase to5% of the population which makes more than 7 million people.

Apart from the level of income, the number of people investing in shares is influenced also by thefollowing factors: efficiency of the protection of the minority shareholders interests, the standards of thecorporate governance, the level of the individuals awareness about the means and forms of investments,about their rights as investors, as well as the general level of the financial competence of the population.The populations participation in investment business can take two main forms which are the directparticipation of the individuals in investments (with the help of the brokerage service of professionalparticipants of the stock market) and the participation of the population in the investment and pensionfunds. There is also an intermediate form of the individuals involvement in the investment business which

consists in the service of the beneficial ownership of securities on the basis of an individual contract aboutthe trust management.

The priority of one form of the individuals investments organization over another must bedetermined by the countrys particularities of investment activities which, in its turn, depend on a series ofparameters including cultural and historical traditions. In Russian professional environment there hasrecently become popular an idea of the development of the collective investment funds.

However, other countries experience gives evidence to the fact that the mechanism of minorprivate investors activity within collective investment funds is not so successful. The example of theRussian particular way of thinking can be the minor private investors aspiration t o invest in certain joint-stock companies shares. Thats why the stimulation of the Russian population to invest in shares is themost popular direction in strengthening the populations role on the stock market. The reason for this isthat its mostly the direct investment of the population in securities that can bring the biggest influx offunds on the Russian stock market in the coming years.

Besides, its necessary to point out that under certain conditions the individuals high activity ininvestments on the stock market with the help of brokers may lead to the destabilization of the stockmarket if investors tend to speculate instead of long-range investing. The number of potential long- range


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investors is currently much higher than the number of minor short-range stock-market speculators.Enabling this reserve of the growth of the number of investors on the stock market will lead to its higherstability.

Thus, the involvement of the public in financial markets is one of the main targets of the formationof the GFC in Moscow. And due to the lack of development of collective investment institutions and othermarket investment mechanisms available to the public banks are able to become the main link betweenthe financial market and the public. The more so as an increase in the financial activity of the public isincluded in their sphere of interests: the more people are financially active, the more potential customersthe bank has. And banks have to become the vehicles of the financial information, since the majority ofRussians are unfamiliar with both investment instruments and other financial products, and have only theslightest idea of how they can make use of various financial services

Investment preferences of individuals

When considering peoples investment preferences, you have to keep in mind that peoples primarygoal isnt to multiply their money, but to save it. The driver of the segmentation of the nations savings is areliability and invulnerability to risk.

According to NAFI studies (12.21.2010), every second Russian (48%) considers the real estate tobe the most reliable form of investment, and every third chooses bank deposit. At the same time, no morethan 4% of the population believes in the deposits security in commercial banks.

Gold and valuables are also considered as one of reliable forms of saving spare money. Every fifth

Russian remarked this. Accumulation of money in rubles and keeping it in cash is considered to bereliable for 12% of respondents, and not for more than 7% of Russians it is safe to keep money in dollarsand cash euros.

During the financial crisis, people preferences have changed in favor of bank deposits. And at firstsight it seems counterintuitive. Firstly, people realized that this crisis would be continuative, so it is betterpossibly to save money than to spend savings, in case of even worse situation. Secondly, thegovernment has significantly increased the amount of insurance indemnity compensation under thegovernment guarantees of bank deposits up to 700 000 rubles. Thirdly, in 2009, many banks offeredattractive interest rates on deposits which for the first time in many years has led to possibility of receivingthe income from bank deposits not only nominally but also virtually adjusted for inflation. Finally, after allperplexities of the crisis no massive upheavals that led to the loss of deposits on the banking market haveoccurred. The growing interest and confidence in bank deposits from the population of the country is dueto this fact.

The main categories of the public and the extent to which theyparticipate in the use of financial products

It is fairly obvious that one of the main factors hindering the development of the financial sector is aweak development of collective investment institutions, which, in its turn, is directly related to the lowinvestment activity of the public. What is the reason of this? It is possible that the public is not yet ready toactively participate in financial transactions. The history of the market economy is just 20 years old inRussia while the US public has more than a century experience in private investments.

Description of financial activity of individualsThe level of financial activity of the Russian population is quite low as compared with Europe and

the US. However, recently the improvement of this indicator has been observed.According to the research every fifth Russian (19%) is going to use any of financial services within

the next few years. Besides the most popular financial service is a loan but no more than 9% of Russiansare intending to ask some credit in a bank. Among those who are planning to do this, the most popularcredit is a consumer credit - 62% of future borrowers intend to issue this credit. Car loan attracts a quarterof potential borrowers, and 23% desire to use mortgage. Another 9% of future borrowers are going tostart using credit cards.

The second most popular thing is debit cards. 5% of Russians are going to draw up a card(including for salaries, pensions, scholarships). 4% of people are going to make a bank deposit (a timedeposit or a call deposit). No more than 4% of Russians intend to use any insurance program, investmentservices or non-state pension funds (NPF) services.

Such low level of financial activity of the Russian population is a consequence of financial illiteracyof the modern Russian society. According to the Head of the Treasury Department Andrew Bokarev at

the conference upon the problems of financial literacy: approximately 62% of Russians prefer not to useany of the financial services, regarding them to be too complex and incomprehensible. The fact is thataccording to opinion polls, most Russians make decisions about managing their finances and pension


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savings not on the basis of received information but on the recommendations of friends, fellows, andconcerned assistants of banks or companies. Especially it concerns certain financial products: not morethan one third of Russians is aware of the operating system of so-called co-financing of pension savings,only 45% know about the deposit insurance system. In addition, only half of 45% polled knows about thedeposit insurance system, having heard the name they can not explain its essence20.

Since June 2008, the National Agency for Financial Studies conducts the constant monitoring ofthe financial literacy of the population. Its research and surveys allow to estimate the level of financialliteracy and to monitor the dynamics of this indicator. However, it is important to understand that suchstudies may cover only a small sample, and as a consequence, not quite accurately reflect the currentsituation. As a result, data from various studies may differ significantly.

According to the polls conducted by NAFI, the value judgment of the financial literacy of Russiansis increasing: in comparison with that of 2008, the proportion of Russians who consider themselvesfinancially literate, has increased: today 22% of the population determine their knowledge as 'good', 44%- as satisfactory. The share of those who defined knowledge as awful, has dropped from 21% to 7%.

However, the dynamics of objective indicators of financial literacy is not so optimistic. MostRussians do not keep records of family, and 13% of respondents admit that they dont evenapproximately know how much they have received and how much they spend in a month. Percentage ofrespondents who do not keep such records, has not diminished and it has even increased from 56% inDecember 2008 to 69% in February 2010.

Nowadays, financial institutions offer different types of public services, with the varied conditions of

these services. To select the appropriate service it is necessary to conduct a preliminary analysis of theproposed financial products and compare them. However, only one third of Russians practices thecomparison of conditions for providing services.

What is concerned about the stock market, according to the MICEX studies, 39% of investors andpotential investors are aware of the stock market better than others, but they also do not know manyaspects of investments. 22% of polled are competent in certain aspects, but still do not know manythings. 30% admit that they do not understand investments, and the remaining 9% know almost nothingabout the stock market and investments.

The main problems of competence of present and future investors are connected with badknowledge of the stock market and its institutions, lack of knowledge of modern financial instruments andmodern realities of circulation of securities21.

These indicators of financial literacy cause the major concern.According to the NAFI report "Criteria for financial literacy and ways to improve it", the high level of

financial literacy in the country has the most positive impact on the economy of the state, and thestandard of well-being, and income of its citizens.Firstly, it increases the level of financial products usage, transparency of the financial market and

market stability.Secondly, it helps to increase the number of honest borrowers, reducing credit and reputational

risks faced by banks.Thirdly, the high level of financial literacy increases the financial prosperity through the

rationalization of the family budget, increasing the planning boundaries, developing the ability to financeduring a familys life.

Besides it provides the protection from fraud and increases the financial security of citizens.Another important factor of the low financial activity of the population is negative experience connectedwith the financial market. During the 90-s the confidence in the banking system and the financial marketin general has been lost as a result of freezing of accounts in Sberbank, loss of savings due to the 1998

default and frauds with the financial pyramids.To estimate the degree of public confidence in financial institutions the index of confidence infinancial institutions is used. The total index of confidence in financial institutions in 2010 amounted for 97points. The index, reflecting, population's expectations about the reliability of financial institutions22(confidence in the safety of funds, compliance and the absence of fraud with clients) was 97 points lastyear. The degree of confidence in the financial system over the past two years has remained almostinvariable; the absence of positive or negative dynamics shows the certain stabilization in theexpectations of the individuals.

However, it is important to understand that distrust of financial institutions is directly connected withlow financial literacy. According to the NAFI studies only a quarter of Russians can recognize the financialpyramid. 26% give the right answer to this question - the financial institution that promises 35% growth ofinvestments in a year and guarantees a return on investments. While 9% believes a pyramid scheme to

20http://www.minfin.ru/ru/press/speech/index.php?id4=9653,May,12,201021 http://www.iblf.ru/files/common/finlit/conf91208/micex912.pdf22 The Index calculation is presented in Appendix
http://www.minfin.ru/ru/press/speech/index.php?id4=9653http://www.minfin.ru/ru/press/speech/index.php?id4=9653http://www.minfin.ru/ru/press/speech/index.php?id4=9653http://www.minfin.ru/ru/press/speech/index.php?id4=9653


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be a mutual fund reporting a 35% return of its shares over the previous year, while 8% of respondentsbelieve it is a bank deposits with 12% per annum.

Segmentation of banking products usersThe structure of the population is heterogeneous and the degree of financial activity varies by age,

social status and wealth. Taking it into consideration, you've come to the conclusion that it was time tolearn the study report, which has already been delivered a couple of days ago, namely, to the report,

"Segmentation of banking products users."During the segmentation of users of banking products the members sample were to satisfy the

following conditions:Men and women 21 -65 years;Restrictions on income: a level sufficient to cover basic needs, and more;Use any banking product (account, deposit, card, credit, mutual funds).As a result of segmenting consumer banking products 8 segments that differ according to the

finance, styles of life, age, social status and income were pointed out. The number of segments, withinthe constraints of the target audience accounted for 19.5 million.

The yuppie segment (18%), age 25-35 years, a high income. Usually specialists, managers.34% live in Moscow, 66% in the regions. They are oriented to modern values, keep up with the fashion,go to the expensive, prestigious shops, like to travel abroad, to use the Internet. Yuppie believe thatthey understand the system of banking products well, and they are ready to buy on credit if necessary.

They actively use bank products. The level of use of services of the Moscow Bank is above average (10%of people in this segment use the services of the Moscow Bank). Now they use debit cards, car loans,mortgages. Within the next six months they are going to use auto loans, credit cards and mortgages.

The segment of wealthy middle-aged people(21%), age 36-47 years, a high income. Basically,managers, experts. 36% live in Moscow, 64% - in the regions. They are oriented to the modern values.They like to travel, to pamper themselves and actively use the Internet. Representatives of this segmentrate their knowledge of banking products as average, they are ready to take a loan credit only on a lastresort. They actively use bank products. The usage of services of the Moscow Bank of Moscow (8%) isabove average. Now they use the system of deposits, credit cards, auto loans. Within the next six monthsthey are going to take a deposit or credit card.

The segment of active middle-aged men (11%), age 36-45 years, their income is above average.Basically managers, experts. 20% live in Moscow, 80% - in the regions. They are oriented more totraditional values. They spend their vacations at home or in the country, they are very serious about the

opinion of other people, do not go to expensive shops, while actively using the Internet. Members of thissegment rate their knowledge of banking products as average and they tend to make purchases oncredit. They actively use bank products. Today they use cash in the bank loan, credit cards, loans fromstores. Within the next six months they are going to use a credit card. Services of the Bank of Moscowenjoy 6%of polled uses the services provided by the Moscow Bank.

The segment of "carefree young proletarians" (12%), aged 21-30, the average yield. Theiremployment status is usually experts, employees and workers. 13% live in Moscow, 87% - in the regions.They focus on the modern values, try to stand out of the crowd, like competition, are inclined to heed theadvertisement and are actively using the Internet. They estimate their knowledge of banking products asa midi and are fully accessible for the use of credits. They use banking products with moderate activity.Today they use cash credits in banks, credit cards and take loans in stores. These products aresupposed to be used in the next 6 months. The part of the Bank of Moscow in this segment is 4%.

The sixth segment is made by the so called rational young people (3%), the age group 25-35years, with the income higher than average. Mainly, women. The professional status specialists,industrial and office workers. 28% of them live in Moscow, 72% - in provinces. They are oriented on themodern values. They keep up with the fashion, like to stand out in the crowd, love travelling acrossRussia, use Internet. This group believes its not well aware of the bank services, and has a suspiciousattitude towards loans. They are inert in terms of bank products. The Banks of Moscow services are usedby 7% of the respondents of the segment.

The seventh segment is pre-pension employees (18%), the age group 43-55 years, the income isaverage. Mainly, women. Mainly, industrial and office workers. 10% lives in Moscow, 90% - in provinces.This group is oriented on traditional values. They spend their holiday in a country house, in their sparetime they watch TV or look after the house. They believe they hardly know anything about the bankproducts but are ready to make a loan. The activity of using bank products is moderate. The use of theBanks of Moscow services is lower than the average (2%). At present time they make a cash loan in abank or in a shop. They are planning to practice the same services in the next 6 months.

The eighth segment is pensioners(14%), the age group 55-65 years, with the income lower thanthe average. Mainly, women. Mainly, industrial workers and pensioners. 14% lives in Moscow, 86% - inprovinces. This group is oriented on traditional values. They buy only necessary goods, they prefer


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spending their holiday in a country house or at home, in their spare time they watch TV or look after thehouse, do not use Internet. They believe they hardly know anything about the bank products and are notready to make a loan. No activity in using bank products. The use of the Banks of Moscow services islower than the average (2%). At present time they prefer a deposit. They are planning to practice thesame service in the next 6 months.

Today there are 6 segments that make 83% and about 15 million people that can be attracted touse the Banks of Moscow services. These groups are the Yuppies, the successful middle-aged, theactive middle-aged, the carefree young proletarians, the rational young people and pre-pensionemployees. To attract these segments to an active use of different banks products its highly important todraw the image of the Bank of Moscow which should be oriented on the necessity of these groups in anactive way of life, a high social status that reflects their ambitions.

The range of attractiveness of the bank products established on the basis of the estimation of theaverage sum and the cash volume on each product is the following. The Yuppie are more interested in acar loan and a credit card; for the successful middle-aged its a cash loan in a bank, a car loan, a creditcard; for the segment of the active middle-aged the most popular service is a deposit; the carefree youngproletarians prefer a cash loan in a bank and a credit card.

Financial products and their penetration on the Russian market ofphysical persons

The latest 10 years, being relatively favorable, have made a contribution in the forming of amiddle-class which is the main target group in the promotion of the banks services. The key task of thebank is understanding the way it can help its clients to solve their problems. Thats why, currently, one ofthe main trends in the retail bank service system is to set close relationships with client, guiding themthrough all their life providing with different type of necessary services like deposits, loans, plastic cards,investment products and other se

Documents

CL-Case-1 Round-Bankers of the World (ENG)